Felix Salmon

We knew there was a lot of nuclear waste on Lehman’s balance sheet. But we didn’t know that was literally true:

Lehman Brothers Holdings Inc. is sitting on enough uranium cake to make a nuclear bomb as it waits for prices of the commodity to rebound, according to traders and nuclear experts.

At least uranium can in theory be used as a force for good, in nuclear power stations. Which is more than can be said for CDO-squareds.

(Via Wiesenthal)

If a bank passes a meaningless stress test and nobody hears about it, will the Treasury market rally? Or will there just be lots more volatility in bank share prices?

Answers on the back of a postcard please to T. Geithner, 1500 Pennsylvania Avenue, Washington DC, along with any other unintended consequences of the current making-it-up-as-we-go-along approach to bank regulation.

At the very least, Treasury needs to be much clearer than it has been about exactly when and how the results of these stress tests are going to be made public. And when in doubt, it should release more information more quickly, rather than going the standard Washington route of keeping stuff secret. Because these results are so important, and known to so many people, that they will leak if they’re not released soon.

Pejman Yousefzadeh is upset:

The brain drain that the American financial service industry may face thanks to increasing regulation, the pursuit of class warfare rhetoric and policies by the Obama Administration and its allies, and the tendency to blame the current economic downturn on entities like hedge funds, which had nothing to do with the financial crisis, will only serve to hurt the American financial service industry down the road.

Well, yes. Think of it as a Pigovian policy response: you tax and regulate the stuff you want less of. And it’s pretty clear that the financial-services industry was far too big, before its crash. Recall Simon Johnson:

From 1973 to 1985, the financial sector never earned more than 16 percent of domestic corporate profits. In 1986, that figure reached 19 percent. In the 1990s, it oscillated between 21 percent and 30 percent, higher than it had ever been in the postwar period. This decade, it reached 41 percent.

Financial services companies are meant to be intermediaries, middlemen. And any time that the middleman is taking 41% of the total profits in what’s meant to be a highly competitive industry, there’s something very wrong.

So yes, I do want to “hurt the American financial service industry down the road”, if by “hurt” you mean bringing its profits down to something less than 20% of all domestic corporate profits. That doesn’t seem unreasonable to me. And I especially want to hurt the American financial service industry down the road if by “the American financial service industry” you mean the too-big-to-fail banks which have caused such an enormous systemic risk to the global economy. Yes, I want to see them hobbled, much less powerful, and much less dangerous.

So no, I don’t have any particular interest in buying freshly-issued shares of Goldman Sachs at these levels. Buying shares is a bet on steady future growth. And Goldman is too big already. I want it to get smaller, not bigger. It was the imperative to grow which caused many of the problems at places like Merrill Lynch and Bear Stearns. Which makes this kind of equity offering part of the problem, not part of the solution.

Matt Taibbi is blogging over at True/Slant, the new website which managed to get itself a fully-fledged Mossberg review last week. Taibbi’s blog is fantastic, and the site looks great. But a few of the site’s early decisions make me bearish on its future.

First, the site’s RSS feeds are truncated — which is simply idiotic. Second, the list of executives (five of them, four with the word “chief” in their name) gives no contact information for any of them: they’re closing themselves off from their readers.

Third, you can’t comment without first registering — another way of the site closing itself off from its readers. (I tried to register, and am supposed to click on a link in an email they were supposed to send me, but I never got the email.) In general, I never fail to be astonished at the number of new blogs which by default, at launch, assume that their readers are so unruly and untrustworthy that all manner of registration or comment-moderation firewalls need to be put up before they can interact with the site.

It’s true that when sites become extremely popular, comment trolls can become a problem. And I’m sure that True/Slant has every intention of becoming extremely popular. But it’s not there yet. So it’s depressing to see how difficult they’ve made it to (a) comment in the first place, and (b) read other people’s comments, if those comments haven’t been “called out”. It makes readers feel like third-class citizens, rather than people interacting with the bloggers as peers. And it’s the kind of thing which should only be implemented when things get so bad that you have no choice.

Shortly after I started blogging for Portfolio, I was quite rude about a Ben Stein column in which he described the lack of any Wal-Marts in midtown Manhattan as “an enduring mystery of the retail economic world”. In September 2007, I officially started the Ben Stein Watch, on the grounds that “we have to stop Ben Stein from writing for the Times. Right now.”

By the time I left Portfolio, the Ben Stein Watch archives (conveniently available at bensteinwatch.com) amounted to 60 separate blog entries, totaling 33,776 words. And although they were popular, they never achieved their stated aim: Stein is still writing for the NYT. But I’m putting the BSW to an end right now.

One reason is that Stein’s columns have ceased to be infuriating to me: instead they tend to lie somewhere between boring and incomprehensible. Another reason is that if Stein couldn’t get himself fired from the NYT for making Expelled , there’s simply no way that a lone blogger is going to have any effect. But mainly I just want my Sundays back — I have better things to do with what is meant to be a day off than try to decipher stuff like this:

If some of us want to help posterity, and help it survive the tsunami of debt, we might be more likely to save when our mood is low (as against the times when we are all happy and positive about the future).  

And so I’ve decided that the BSW won’t follow me from Portfolio to Reuters. I probably won’t ignore the man completely, but I will no longer feel compelled to blog every single NYT column he writes. If anybody wants to take over the franchise, they’re more than welcome to, and I’ll happily provide lots of link love — I might even submit a guest post once in a while.

If you ever wonder, however, whether a Ben Stein column might be making sense, just remember this: the man wrote a book entitled “Yes, You Can Time the Market!” and then wrote this:

I’m writing this on Aug. 13, 2007… the stock market is cheap on a price-earnings basis, profits are fabulous… and in the long run, both here and abroad, stocks are a lovely place to be.

Oh yes, and he also declared, more than three months into the deepest recession in living memory, that “as a matter of definition, we simply cannot be” in a recession at all.

So it’s probably best just not to read the chap. Since paying attention to his atrociousness clearly hasn’t worked, maybe ignoring him will have better results.

Job Sprawl: And why it’s not a great idea to start extrapolating.

Look Into the Sun: The no-advertising business model. Doesn’t seem to be doing particularly well these days either.

The Best Minds of My Generation: Are going to be trying to game the PPIP. Is this a feature or a bug? See also Mike on risk management, and the incentives that banks have to shove the maximum amount of risk possible into the tails. (This is what I call the “Rubin Trade”.)

Why is Good Friday a Stock Market Holiday: I love this: “Two or three years in a row during the 1890′s, there was a big drop in the market on Good Friday. Traders took it as a sign from God that he didn’t want the exchange open.” Because God is a stock market bull, obvs.

Henry Paulson’s Son Finds Dad’s Money Won’t Buy Soccer Bliss: As Ryan says, funny on so many levels.

Nick Gogerty has a great post using this chart to explain why mutual fund managers are doomed to underperform the stock market. Yes, stocks as a whole do rather well — but only if you include the really spectacular winners. If you buy the market and a whole and make money doing so, you’re basically following a strategy of making sure that you include the spectacular winners by making sure that you’re including pretty much everything.

Nick explains that while the mean return for the stock market is quite good (or at least was between 1983 and 2007, which was the dataset for this graph), that isn’t true for other kinds of average:

The median and mode for shares returns is actually well below the cap weighted index which is closer to the mean. The charts above indicate 64% of shares under perform the index. This means that managers who “tilt” or weight their portfolio to their best ideas are statistically taking a random sample and doing bad things, increasing the odds of picking sub-index performance and in so doing also diminishing the allocations to the potentially significantly positive outliers that help deliver the mean performance.

Any good fund manager will tell you that, in hindsight, his best stock picks weren’t his best ideas. But it’s really hard to find a fund manager who won’t overweight his portfolio to the stocks he most believes in. And that’s one of the reasons that I’m suspicious of value investing: it’s full of investors who have done so much homework that they’ve convinced themselves they’re right — and they just won’t let go. This results in great stories, but it doesn’t necessarily result in great returns. Quite the opposite.

Justin Fox revisits the January payrolls report, and finds some scary numbers most of us missed the first time around:

January 2009 was a truly, spectacularly bad month for non-farm payrolls. It was bad enough in seasonally adjusted terms: 741,000 jobs lost. But when you look at the raw data it is truly staggering: 3.6 million jobs gone. There’s always a big decline in employment in January as all those Christmas-season jobs disappear—that’s why the Bureau of Labor Statistics adjusts the data for seasonal factors. But in normal times it’s a decline of 1 million jobs or so. This January accounts for about three-quarters of the total job loss since the fall financial panic.

I find it hard to believe that any economy which managed to shed more than three and a half million jobs in one month is anywhere near recovery. Most of the time, job losses are a lagging indicator. But they’re also, when they approach this kind of magnitude, an important driver of economic activity: people who have just been laid off simply don’t spend money. And a marginal extra 3.6 million people not spending money amounts to a pretty unstoppable force in exactly the wrong direction. If each of those people reduces spending by $1,500 a month, then that’s $65 billion a year right there being sucked from the economy. And that’s just the job losses from January this year.

What’s worse is that you have to get quite a long way into a recovery before businesses feel so upbeat that they start hiring again. New job creation is an incredibly powerful force, but it’s also something which works over the long term, not the short term. In the short term, mass layoffs have a much larger effect. And they’re not over yet.

Justin Fox does us all the favor of asking — again — why we’re bailing out banks rather than borrowers. If I had to give a simple answer, I’d say that it was because the failure of Lehman brothers has shown us that we simply can’t afford not to bail out the banks. If banks’ creditors in general, and their senior unsecured bondholders in particular, are forced to take massive haircuts on their holdings, we could suffer another sickening downward lurch in the fragile credit markets, with nasty knock-on effects for the economy.

But I’m not entirely convinced that the simple answer is necessarily the correct one. I just got a very smart question via email from Liaquat Ahamed, author of the excellent Lords of Finance :

Lehman had a balance sheet of around $800 billion, $30 billion of equity, $120 Billion of unsecured debt and $650 billion of secured debt (repo etc). The secured debt was fine, the unsecured debt got paid out at 20 cents on the dollar and the equity went to zero. Total loss was $100-120 billion.

As I understand it no counterparties in the US lost any significant amounts of money. Counterparties had been worried about Lehman for a while and had collected margin on unrelaized gains on outstanding trades. In the UK there were some losses from the practice of rehypothecation by the prime broker but even here the losses were only in the tens of billions.

The main impact of the Lehman failure was psychological. The Reserve fund broke the buck the next day from losses on Lehman commercial paper but even then the run on money market funds was contained. Everything the Fed then did that week was designed to contain the psychological damage from the Lehman collapse.

I sort of buy the John Taylor idea that it was the failure of Congress to approve Tarp on the first go around that really spooked everyone and raised the specter that the US would not bail out its banking system.

I’d add to this the fact that when Washington Mutual went bust with massive losses for unsecured bondholders, the systemic implications were relatively small: while it’s received opinion that the Lehman bankruptcy was devastating, very few people (other than John Hempton) think that of the WaMu implosion.

Politically, it’s extremely difficult to pass a bill giving hundreds of billions of dollars to people who borrowed money and now find themselves incapable of repaying it. But then again, it’s politically just as difficult to give that money to the banks who lent it, too. And as Steve Waldman notes, the alternative to not bailing people out is basically to force “prudent” investors and savers to take losses instead:

Don’t go all Rick Santelli on me about the injustice of paying for your asshole neighbor’s granite countertop. We are bailing out a banking system that served as a vast criminal conspiracy built around plausible deniability and limited liability. We are bailing out “savers”, who not only demand to be made whole by the government on risky loans they chose to make to banks for profit, but are smugly self-righteous about it, like it’s their “right” because after all they were the “prudent ones”. Of the three groups we might bail out, these crybabies and criminals are no more deserving than some nearly-broke bastard who believed his financial adviser, his banker, his mortgage broker, and the Wall Street Journal op-ed page when they told him that a cash-out refi was as good as money earned, and that granite countertops were a luxury that would pay for themselves. Don’t get me wrong — I’d rather we could bail out no one, just do a rip-off-the-band-aid kind of reset and let everybody take their lumps. But households and firms in debt are by far the most sympathetic villain in this horror show we wake up to every day.

So maybe we should be spending less time on the banks and more time on the borrowers. Yes, bail out the banks — but don’t do it directly; do it indirectly, instead, via the borrowers. Maybe the banks will take slightly more losses that way. Fine. That just means the banks creditors will be more bailed in than they have been to date, and the current market price of the debts will be justified. And at least it will be ordinary Americans getting the government bailout, rather than multi-billion-dollar corporations who utterly failed at their primary job of managing risk.

Thornburg Borrowers Unite is a new blog for people with mortgages from now-bankrupt Thornburg. Those mortgages are for sale, at a discount: why can’t the homeowners themselves buy them back? “If Thornburg can be persuaded to give its borrowers right of first refusal,” goes the argument, “it costs taxpayers nothing, and it prevents third parties from profiting from our losses and the demise of Thornburg.”

This is entirely true, and it seems like a perfectly good idea. But there is one small problem with it — the issue of adverse selection, from the point of view of the investor buying up Thornburg’s mortgages.

If I’m putting in a bid on a large number of Thornburg loans, I know that some will perform well, and be worth more than par, while others will perform very badly, result in foreclosure, and be worth maybe 30 or 40 cents on the dollar to me, all told. Net-net, I might be willing to pay 60 or 70 cents on the dollars for those loans.

The borrowers are saying that if Thornburg is willing to sell their loan to an outside investor for 69 cents, it should be even more willing to sell that loan back to the homeowner for 70 cents. But in fact it’s more complicated than that. The homeowners who are willing and able to buy back their own loans for 70 cents on the dollar are generally the most valuable of Thornburg’s borrowers — they’re overwhelmingly likely to be the ones whose loans are worth par, or more. So if Thornburg allows them to buy their own loans back, the value of the remaining mortgages goes down, and the investors aren’t going to be willing to pay 69 cents on the dollar any more.

And it’s also not strictly true that doing this “costs taxpayers nothing”. If I borrow $500,000 from Thornburg and then buy that debt back for $350,000, I’m basically making a $150,000 profit, which would normally be taxed as income. Recently, the government temporarily suspended the laws forcing me to pay income tax on that $150,000. But the more people who buy back their mortgages at a discount, the more income tax is foregone by the Treasury.

All that said, the idea behind the blog is a fundamentally good one: anything which provides a new bid for legacy mortgage assets should be encouraged. I wish these people well, and hope they get somewhere with their campaign.

The typical overdraft fee these days is in the $35 range. And how much is borrowed when people get an overdraft? The thing is that most of the time the overdraft is inadvertent — which means that the account drops only a tiny bit below zero. In the case of debit-card transactions, the average overdraft is only $17. And as a result, as the chart above shows, if you go overdrawn as a result of a debit card transaction, you’re likely to pay $1.94 in fees for every dollar you borrow.

Other methods of payment have lower fees per dollar, but not much lower: if you go overdrawn as a result of with drawing money at an ATM, you’re likely to pay 78 cents per dollar in borrowings, while if you transfer funds electronically, you’ll pay 98 cents. If you write a check, the number is 73 cents.

This is what the likes of John Hempton are talking about when they say that banks are inherently enormously profitable, and that if we just leave them to their own devices and prevent them from paying dividends, they’re likely to become solvent again sooner rather than later, just by dint of how much money they make day in and day out from their operations.

But the question is: do we actually want to live in a country where banks lose money on stupid loans and make it up by socking the poor with exorbitant fees? (It’s not the rich who generally pay those $35 overdraft fees.) If you look at the entire global banking sector over the history of the modern world, I’m pretty sure that looking at interest income alone, it has lost an enormous amount of money in aggregate. Those losses are paid for, generally, by some combination of government bailouts and increased fees. And that’s just not a model I feel comfortable with. Hempton thinks that banks should be both boring and highly profitable; I think it’s worth asking where those profits are coming from before we start embracing that idea too ardently.

(Source: page 38 of this PDF, via Amanda Clayman)

Regulatory Capital Arbitrage: “With hindsight, there was too little capital allocated for mortgages originated between 2005 and 2007. Then again, with hindsight, they had a negative NPV, and should not have been issued by any rational profit maximizing firm.”

U.S. Imagines the Bailout as an Investment Tool: It’s still extremely unclear what kind of retail investors are supposed to want to invest in this stuff. What kind of risk profile fits a potential retail investor?

REO Hack Job: Paul Jackson takes on the NYT. “This isn’t insight; it’s a poorly-executed witch hunt masked as real journalism.”

Google and the Temptations of Being Cash-Rich: Why Google should give up its cash for reasons of self-discipline.

Zachary Seward has an interesting interview with wsj.com’s Allan Murray, who is sounding reasonably similar to the FT’s Rob Grimshaw, although even Murray says that he finds FT.com’s bizarre business model “very confusing”.

The WSJ seems to be moving towards something of a barbell strategy here. On the one hand there’s a lot of free content: Murray lists not only “all our political coverage, all our opinion coverage, all our arts and leisure coverage”, but also any “big news story” as the kind of stuff which anybody should be able to read for free. Plus, of course, there’s any story which you get to via Google News.

At the other end, there’s very expensive niche content:

I think what you have to think about is sort of narrower groups of interest where the interest might be deeper and more intense and therefore might make people willing to pay for it…

We’re working on a premium initiative to launch a series of, as you say, niche or narrower information services that we can sell at a premium to smaller groups of subscribers on subjects that they care most about.

The FT has already started going down this road, with the launch of its China Confidential product. There have been three biweekly issues so far, and a subscription will set you back somewhere in the £2,000 or $3,000 range.

How many subscribers does China Confidential have? One, I think, although the number might have risen all the way to three or even four. There will probably be more, but I’m not at all convinced that this kind of business is a smart one for the FT and WSJ to be in.

I’ve spent a fair amount of time among both FT and WSJ reporters, on the one hand, and financial trade-magazine and newsletter journalists, on the other. Essentially, the FT and the WSJ are trying to move in to the newsletter space — but are trying to do so with their present cadre of reporters. And newspaper reporters don’t tend to be nerdy enough to get excited by the finer details of the platinum-molybdenum relative-value play: they’re always more interested in the big stories.

What’s more, FT and WSJ reporters have a habit of believing that they’re extremely good, just because they get big stories. But of course it’s always much easier to get a big story if you can say you’re calling from the FT or the WSJ than it is if you say you’re calling from some publication which will only be read by a handful of super-premium subscribers.

Indeed, there might well be an element of bait-and-switch going on here: WSJ reporters will get stories wearing their WSJ hats, only to publish them behind ultra-high subscription firewalls which are impenetrable to the overwhelming majority of WSJ subscribers. This is unlikely to impress anybody — not the sources, not the subscribers, and not even the suits, who will eventually realise that their franchises are built on having reach. The FT’s Lex column, for instance, is influential precisely because it’s read by hundreds of thousands of commuters on their way in to work in the morning. The more expensive you make it, the less that it’s read, and the less that it’s read, the less influential it is.

My feeling is that Murray’s latest bright idea is doomed. He’s giving away most of the stuff that people want to read, and he’s trying to make money from selling stuff people need to read. The problem is that for all the WSJ’s astonishing levels of self-regard, there’s precious little of that material out there. Open the paper and ask yourself how much of it really isn’t replicated, for free, anywhere online. The answer is that there’s very little — certainly not enough to persuade hundreds of thousands of people to pay good money for an online subscription.

When people subscribe to wsj.com, they do it because out of a desire for convenience: the knowledge that they can get whatever they want in one place. They’re not, in general, paying this money out of a feeling that they simply can’t live their lives without this particular source of information. And when the WSJ starts trying to charge thousands of dollars for premium content — when it walls off stories even from its own subscribers — a lot of the convenience that people are paying for, the knowledge that all the WSJ’s content is available to them, evaporates. Subscribers hate running into super-premium firewalls: it makes them feel second-class. And it’s the broad mass of subscribers which the WSJ will get the overwhelming majority of its revenue from. It’s a good idea not to annoy them — or they’re prone to start finding their news elsewhere.

Neil Irwin has a nothing-new-here profile of Ben Bernanke in the Washington Post. What struck me, however, was the way that his collegial style was characterized very much in terms of what (and, implicitly, who) it’s not:

To many Fed veterans, his leadership style is a stark contrast with that of his predecessor, Alan Greenspan, whose tenure was characterized by tightly controlled decision-making with only rare open disagreement.

“It’s not Ben’s personality to pound the table and scream and say you’re going to agree with me or else,” said Alan Blinder, a former Fed vice chairman and longtime colleague of Bernanke’s at Princeton University. “It’s not his way. I’ve known him for 25 years. He succeeds at persuading people by respecting their points of view and through the force of his own intellect. He doesn’t say you’re a jerk for disagreeing.” …

“The chair of any committee can respond to comments that challenge his view in ways that essentially inform the committee that the issue isn’t worth discussing. This chairman doesn’t do that,” said Jeffrey M. Lacker, president of the Richmond Fed, who worried that the Fed was putting itself in the uncomfortable position of allocating capital in the economy. “He takes other views seriously.” …

“He tries to bring as much input as possible,” said Kansas City Fed President Thomas Hoenig. “He’s always been willing to ask questions, accept input and be responsive to that input.”

We probably knew that Alan Greenspan was never a big fan of getting lots of input from the FOMC. But this looks to me very much as though Jeffrey Lacker is going on the record as implying that Greenspan didn’t take other views seriously, and that Alan Blinder is going even further than that.

Once upon a time, even after Greenspan’s departure, such high-ranking officials would have been careful to disavow such implications. Now, they don’t seem to care any more. If Greenspan is upset by this kind of thing, who cares. He’s a historical relic at this point.

David Weidner speaks to Meredith Whitney:

When I asked Ms. Whitney this week if she deserved acclaim for The Call – in particular credit for calling the meltdown – she declined comment…

“The disclosure (at banks) was playing catch-up,” Ms. Whitney said. “You really had to dig deep and pay attention to balance sheets. A lot of people knew the system was overlevered. That’s why finding the inflection point was so meaningful.”

That’s declining comment? It seems like quite a good answer to me. The Call in question was Whitney’s sell rating on Citigroup in October 2007, when Citi was trading at more than $40 a share; it more or less marked the point at which Citigroup’s share price fell off a cliff. (See the graph below.)

Whitney’s point is well taken: it’s one thing to point out that lots of banks had lots of leverage. But it’s another thing to get the timing right and work out exactly when all that overleverage was going to hit them in the share price.

Weidner’s not impressed: he says that “Ms Whitney’s call on Citi wasn’t that great”, and compares her unfavorably to Dick Bove, Mike Mayo, and Charles Peabody; not to mention Nouriel Roubini and Nassim Taleb. But this isn’t some kind of competition with only one winner. And when it comes to research, it’s not just what you say, it’s how you say it. Whitney has the rare ability, among sell-side analysts, to speak in clear and unhedged declarative statements, which has served her very well. Add to that the fact that she was right, and you can see how she became such a star.